Black hole raises spectre of Budget tax rises

The prospect of big tax rises in Gordon Brown's first Budget increased yesterday, as the Government unveiled a pounds 20bn "black hole" in the public finances. The warning that the Government was considerably worse off than previously forecast was seen as an attempt to soften up the financial markets and Labour's back benchers for higher taxes and a tightening of the screw on public spending.

The dramatic shortfall emerged as Gordon Brown, the Chancellor of the Exchequer, announced a series of changes to the assumptions used by the Treasury in drawing up its economic forecasts. Those changes mean the Government now expects it will be forced to borrow pounds 7bn more from the money markets in five years time than the previous Chancellor, Ken Clarke, suggested in his final Budget last November.

Having fought the election campaign on a promise not to raise personal taxes, yesterday's move increases the likelihood that business will bear the brunt of the Chancellor's need to raise revenue. An attack on the tax credits enjoyed by pension funds now looks probable.

The Government predicts similar but smaller shortfalls in all the next five years, providing ammunition for the Chancellor to clamp down on excessive requests from spending departments. His hard-line position was further bolstered this week by retail sales figures showing a continuing boom. Speculation is rising that interest rates will have to rise again to choke off demand.

In a bid to present the changes as part of a move towards more open government, Mr Brown commissioned the independent National Audit Office to scrutinise the assumptions and received its endorsement yesterday.

Mr Brown said yesterday: "Budgets must be built on honest foundations ... It is the first time that any chancellor has opened up the Treasury's forecasting assumptions to such open and independent scrutiny."

The main changes in the government's assumptions are a reduction in its expectations for the long-term trend of economic growth, and a less rosy view of the savings that can be made from clamping down on social security fraud.

The Government has also said it will not count on any privatisation proceeds until legislation is in place for any state sell-off, and it will use information from the financial markets to forecast interest rates rather than open itself up to claims of political interference by using Treasury experts to predict the cost of borrowing in future years.

Finally, Labour has committed itself to using a more pessimistic assumption for the number of jobless than Mr Clarke who last year broke with tradition by forecasting a fall in the unemployment rate.

Although presented as no more than a move towards greater transparency, economists in the City described yesterday's announcement as "an exercise in public relations".